Thursday, June 16, 2005

Liquidity, IPOs and Dubai's development imperative

I have mentioned before the weird and wonderful things that are currently going on in UAE's financial markets. My thinking, at first, was that it was a form of hidden taxation by the ruling families. When Sheikha Lubna al-Qassimi, the UAE's Minister of Economy and Planning, announced that the company law would be amended to allow 'successful' families to launch IPOs in their companies without losing control, I thought that my suspicions were confirmed: the amendment to the law will essentially allow the ruling families to soak up the excess liquidity floating around the region for their own ends.

On further reflection, I don't think that hunch was wrong - but, as ever, there seems to be a great deal more to the story.

The Middle East has a problem: growing populations, whose growth has been in no small part accelerated by the discovery of oil wealth, are now outstripping that wealth. Per capita GDP in Saudi Arabia today is where it was in the early 1970s; around half the population of the entire region is under the age of 25. Across the region, according to the World Bank, "the number of new entrants to the labor force will average 4.2 million a year [during the 2000-2010 period] - twice the number for the previous two decades."

And that's in a region where unemployment is already high, and that's ignoring the un- and underemployment hidden in the region's bloated state bureaucracies.

So how to develop the economy and create all those new jobs? The mantra has long been 'diversification', but there have rarely been any concrete suggestions of how such diversification might be achieved in the Middle East. In Egypt, cash crops and state-led industrialisation didn't work particularly well - mainly because the state didn't really know where to begin. Palestinian economist Yusuf Sayigh recounted to Fred Halliday an mid 70s meeting with Saddam Hussein in which the dictator asked to be told about 'economic development'. It soon dawned on Sayigh that Saddam did not have the education to grasp the issues involved.

Crucial to achieving that diversification, then, is bringing in the know-how to make industrial development work. Multinationals may not be the most popular forms of human organisation in the world, but they are incredible repositories of extremely detailed knowledge, built up over many years, of how to do certain things and how to do them well. Gleaning knowledge from and securing technology transfer from foreign companies is essential to the economies of the Middle East - it is a crucial component of bridging the capability gap which separates MENA countries from effective economic development.

The main mechanism of such technology transfer is foreign direct investment. But the Middle East has been woefully neglected (pdf) in international FDI flows:

The MENA region is only responsible for 0.9 percent of global flows of FDI and 4 percent of FDI flowing to the developing world. The situation is even worse in the oil-rich GCC, which received just 0.1 per cent or one-tenth of one per cent of global FDI and only 7.88 per cent of the region's total FDI inflows in 2002. This is a feeble performance for 5 percent of the globe’s population. In a nutshell, the region has ignored FDI and FDI has ignored the MENA world.

What investment there has been, has largely been in petrochemicals - the route Saudi Arabia is currently taking to try to improve its income and reduce its vulnerability to fluctuations in oil prices (more on that another day). Other types of investment have been fairly minimal.

Meanwhile, local investors traditionally sent their money abroad, where they could earn healthy returns:

Private capital flows from the GCC to other MENA countries are a potentially significant source of future private investment. High net worth citizens of the GCC states have invested roughly $1.2 trillion (about 85 percent of their wealth) abroad, mostly in the United States. Also notable is the considerable amount of outward FDI flows and stock in the Arab world. Kuwait has a much higher outward FDI stock ($1.98bn) than inward FDI stock ($527 mn) as of 2000.

Since 9/11, things have changed somewhat. The huge windfall revenues caused by high oil prices have fattened wallets in the region; and a significant proportion of that US$1.2 trillion has been repatriated as Western countries impose stringent tracing requirements on Arab money. The result: huge amounts of liqudity in the region. And with immature financial markets, all that money is competing for a very limited range of investment opportunities.

Let's take a step back for a second. The MENA region has largely been neglected by FDI (particularly the Gulf, for that matter); and FDI is needed for technology transfer. The problem is that foreign investors don't tend to want to invest if local investors aren't investing - if the locals don't trust it, why should we? So if the ruling elites want to start attracting FDI, they have to start investing, and fast.

The question is: what to invest in? Without clear investment opportunities, all that money could end up going off to China or other countries with fewer scruples about Arab money. So the ruling family of Dubai put some of their oil money into flamboyant figurehead projects and marketed them in an incredibly aggressive way, essentially manufacturing a market out of hype - what they like to call 'supply-led demand".

These IPOs - especially now that the law is being changed in the UAE to ensure that the ruling families don't lose control of the companies being floated - allow the families to suck in large amounts of additional capital which can then be redeployed. IPOs work well in mature markets because investors can take them or leave them: in the Gulf today, IPOs are regularly oversubscribed hundreds of times, making one wonder if there can be anything like a proper market valuation going on. But as a mechanism for securing funds from the public, they're even better than taxation, actually, because you're not limited to nationals: you can compete for investors' money across the Gulf and across the world.

The end result isn't to line their own pockets, however: the ruling family of Dubai is doing this so that it can mobilise capital in the most effective and targeted way possible so that it can build something that foreign investors will find attractive. Once the FDI inflows reach a certain critical mass, they won't stop coming, short of a massive crash.

Avoiding a crash, though - that's another question. Inflation is spiralling out of control and Dubai's property market is dangerously overvalued. Time will tell, I guess...